Jacques Lecompte and Philip a McNeely v. Minister of National Revenue, [1976] CTC 2127, 76 DTC 1104

A W Prociuk:—The appellants, Jacques Lecompte and Philip A McNeely, appeal from the respondent’s reassessments of their respective incomes for the taxation year 1970, wherein, in each case, a sum of $4,950 was added to the appellants’ income on the ground that each of them had received this sum from McNeely, Lecompte & Associates Ltd as a taxable benefit to a shareholder within the meaning of subsection (1) of section 8 of the Income Tax Act as it was then in force. This section reads as follows:

8. (1) Where, In a taxation year,

(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction,

(b) funds or property of a Corporation have been appropriated in any manner whatsoever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation,

otherwise than

(i) on the reduction of capital, the redemption of shares or the winding- up, discontinuance or reorganization of its business,

(ii) by payment of a stock dividend, or

(iii) by conferring on all holders of common shares in the capital of the

corporation a right to buy additional common shares therein,

the amount of value thereof shall be included in computing the income of the shareholder for the year.

The appellants’ ground of appeal is that this sum so received represented part payment in the said year on account of goodwill sold by them to the above-named company, which they had caused to be incorporated in the Province of Ontario on January 2, 1969.

At the opening of the hearing of these appeals, it was agreed by all parties that both appeals be heard on common evidence. The parties also agreed to the following statement of facts, taken from the Notice of Appeal of the appellant McNeely:

1. The Appellant is and at all relevant times was, a member of the Association of Professional Engineers of the Province of Ontario and as such is licensed to practise professional engineeriing in Ontario.

2. The Appellant, prior to 1969 carried on, inter alia, the business of the practice of professional engineering as a civil engineer (hereinafter referred to as the “business”) in partnership with Jacques Lecompte, who is also licensed to practise professional engineering in Ontario. The activities of the business were generally restricted to work involving bridges, culverts, storm sewers, sidewalks and other works which are constructed by Municipal, Provincial and Federal governments.

3. At all relevant times the business was carried on from offices in Rockland, Ontario, and was the only recognized business of this type in that area. The business utilized competent para-professional staff who were able to perform their responsibilities without the constant supervsion of the Appellant and Lecompte.

4. Prior to 1969 the Appellant and Lecompte devoted considerable time and effort in making various government authorities aware of the business being carried on by them, and by 1968 80% of the business was due to contracts with government, or branches thereof.

6. In 1968 the Taxpayer and Lecompie caused a corporation to be Incorporated pursuant to laws of the Province of Ontario, under the name McNeely, Lecompte Associates Limited (hereinafter referred to as the “Company”) to carry on, inter alia, the business of engineering. At the relevant times each of the Appellant and Lecompte owned 50% of the Issued and outstanding shares in the capital stock of the Company.

7. As of the second day of January 1969 all of the business, undertaking and goodwill of the said partnership were transferred by the Appellant and Lecompte to the Company.

9. The Appellant and Lecompte and employees of the said partnership became employees of the Company, and the Company continued the carrying on of the business at the same office address; the clients of the said partnership became clients of the Company.

10. During the relevant times, neither the Appellant nor Lecompte devoted his full time and attention to their employment with the Company.

in each of their Notices of Appeal the respective appellants make the same allegation, which is again taken from the Notice of Appeal of Philip McNeely, where in paragraph 8 thereof it is stated:

8. The aggregate consideration paid by the Company to the Appellant and Lecompte for the business, assets, undertaking and goodwill of the business was the sum of $76,477.52 of which $50,000 was on account of goodwill, payable to the extent of $21,996.63 by the assumption by the Company of liabilities of the business as at January 2, 1969, and to the extent of $54,480.89 by the Company issuing the following shares from Treasury and being liable for payment of the following amounts:

	Appellant		Lecompte
Issue of 50 common shares each of
$1.00 per share	$	50.00	50.00
issue of 1,000 preference shares each
at $10.00 per share	10,000.00		10,000.00
Amounts due to Shareholders	17,190.45		17,190.44
	$27,240.45		$27,240.44
TOTAL			$54,480.89

Schedule A of the agreement of sale dated January 2, 1969, filed as Exhibit A-3, reads as follows:

In reassessing both appellants, the respondent set the value of goodwill of the partnership at $20,000, or $10,000 to each appellant, and any sum received by either of them in excess of that amount was assessed pursuant to the said subsection 8(1) referred to above. Accordingly, the issue is the value of the goodwill of the proprietorship as of the date of sale.

Mr Philip A McNeely testified that in 1966 he and Mr Jacques Lecompte, both civil engineers, formed a partnership under the firm name and style of McNeely & Lecompte as consulting civil engineers, with offices in Rockland, Ontario. At the outset they had one permanent employee and three or four part-time employees for survey work .In 1967 they had four permanent employees and four part-time, and in 1968 they had nine permanent employees. Their first contract was with the United Counties of Prescott and Russell for road building in respect of which the paving was completed in 1969. He further stated that at the outset, over a period of two years, he and Mr Lecompte spent a considerable amount of their time contacting municipal and other public officials in order to establish good public relations and to get to know the people who would be in a position to award contracts to their consulting business. When questioned as to how they arrived at the sum of $50,000 as the value of their goodwill, he stated that their accountant, Mr J Bones, CA, who also testified, supplied the figure after the appellants supplied him with the necessary information.

Mr McNeely stated that, at the time of incorporation, the proprietorship had contracts which the appellants estimated would bring in $200,000 in fees within three years. He stated further that, in order to obtain these contracts, both he and Mr Lecompte cultivated acquaintances, as stated earlier, by promotional work; through hospitality suites which they maintained at conventions; and by building up a reputation of reliability and credibility. When the company was incorporated and the proprietorship sold out to the company as a going concern, the appellants felt that they should recover the value of their effort, financial outlay and time spent in the promotional area to cultivate goodwill.

Mr Bones testified that his clients informed him that each spent about 25 hours per week for two years in promotional work, which he valued at $5 per hour for a total of $26,000; that they had expended a sum of approximately $5,000 by way of promotional expenses; and that he had also added in 10% of the gross fees of $200,000 which they expected to earn on contracts mentioned earlier. These three items totalled $51,000. His clients agreed to a round figure of $50,000.

From the evidence, it does not appear that there were any super profits prior to January 2, 1969. Mr Bones did say that the business was getting established in 1968 and he recommended incorporation. He also mentioned to his clients the income tax consequences which would flow therefrom. The two appellants remained in the company as principal shareholders and I think it is fair to infer that their clientele continued to look to them in the same way as they did before January 2, 1969.

Exhibits A-1 and A-2 were filed essentially to show the letterheads of the partnership and the corporate structure, respectively. Apart from the added words “& Associates Ltd” in Exhibit A-2, the letterheads are basically the same. I also observed that Exhibit A-1 is a copy of a letter written on April 25, 1969 by Mr Lecompte to a client.

Counsel for the respondent called Mr Ralph Rodeis, CA, who was with Revenue Canada for eight years doing valuations of professional, corporate and private businesses and their goodwill. He stated that he worked on the instant case in 1973. He compared it to a similar case he had finalized in the Ottawa district. In this other case, the matter also involved consulting engineers with the one essential difference that their track record was much better, financially speaking. He had valued the goodwill in that case at $20,000. In dealing with the instant case, he stated that at times the earnings had been nil in the past. To arrive at a valuation, he would usually consider super profits of the past and look at future prospects to see what is likely to happen. In the case at bar, he finally placed a value of $20,000 on the goodwill, notwithstanding the fact that in his opinion this was not as promising a situation as the case he had referred to earlier.

In the case of Losey v MNR, [1957] CTC 146; 57 DTC 1098, at page 152 [1101] Thorson, P states as follows:

But the value of the goodwill of a business is what a purchaser would be willing to give for the chance of being able to keep the connection of which it consists: vide Austen v Boys (1858), 11 De G & J 626 at 635; Lindley on Partnership, 10th ed, p 523. And whether the goodwill of a business has a saleable value is a question of fact to be determined in each case: vide Hill v Fearis, [1905] 1 Ch 466. But two things are clear. One is that the sale of the goodwill of a business does not include a covenant by the vendor that he will not compete against the purchaser. If the purchaser wishes the benefit of such a covenant he must provide for it apart from the goodwill. And it Is also clear that the sale of the goodwill of a business does not carry with It a right to the personal services or the business ability of the former proprietor of the business.

At page 153 [1102] the learned President had this to say:

Mr Lebrock was not able to express an opinion on what a prudent purchaser would have been willing to pay for the business by itself but his view was that if the appellant dropped out of it the value of the goodwill would have dropped to nothing. And Mr Gilmour said that where the earnings of a business are dependent on personal effort the value of the goodwill disappears with the disappearance of the owner. And he admitted, in effect, that the value of the goodwill of the appellant’s business without the appellant would have been a very minor amount.

In the instant case, we have a non-arm’s length agreement for sale. The goodwill here is that of professional persons which, as President Thorson has pointed out, does not rub off onto a purchaser, corporate or otherwise. It is doubtful if the company would have attained the success that it did in future years if the two principals, the appellants herein, had dropped out of the picture entirely on January 2, 1969. It therefore seems to me that the respondent, in appraising the goodwill allegedly transferred to the company at $20,000, has been more than generous, and that the taxpayers have in fact nothing to complain about.

Viewing the evidence in its totality, I conclude that the appellants have not discharged the onus the Income Tax Act places on them, and the appeal, in each case, is dismissed.

Appeals dismissed.